Tuesday, September 19, 2017
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The question mark is missing and the answer to the question is "Nothing". The CEO of JP Morgan Chase, the 9th largest company in the world by its capitalization, isn't missing anything.

Philips, an adjunct janitor at Columbia, is even questioning Dimon's simple thesis

You can’t have a business where people are going to invent a currency out of thin air.

Philips teaches us that gold, the Euro, and almost everything else has value that was created from nothing, so it's natural when the same happens in the Bitcoin case. Oh, really? Were these values created out of nothing?

No successful currency or currency-like system has ever been created out of thin air. Maybe some unsuccessful ones, perhaps in Africa, currencies that would quickly undergo hyperinflation, may have been created out of thin air. When Dimon is saying that one can't do such a thing in the Bitcoin case, he hasn't singled out the Bitcoin for some harsh treatment. He is explaining a self-evidently true principle that has governed the whole history of the mankind's economy because it follows from a straightforward quantitative analysis of the human psychology – i.e. from rudimentary economics.

Let's start really slowly. At least thousands of years ago, people were walking and they occasionally found something like this:

A gold nugget. A funny yellow stone. It was more interesting and less usual than other rocks they could see everywhere. A caveman, Mr Fred Flintstone Sr, threw a gold nugget into a fire. His wife, Mrs Wilma Flintstone Sr, told him not to do that. The stone was nice and he was going to destroy their dinner, too. But you know Fred. OK, he threw the nugget to the fire, saw the nugget was melting, the pieces got separated, and one of them got even yellower and nicer than before. "Oh, it's so beautiful," Wilma rarely admitted that she was wrong.

(Readers with PhDs in metallurgy are asked to be tolerant here. The point is economics, not metallurgy.)

Flintstones' neighbors started to create nice pieces of jewelry out of it. Mr Barney Rubble Sr wanted some sex. He was normally paying the prostitutes with apples, or whatever commodity currency they used up to that point. But he noticed that one prostitute who would become Mrs Betty Rubble, was so impressed by a small golden ring that she promised him sex for 20 years in advance. That's how she became his wife. One could have calculated that one golden ring was worth 10,000 apples. Some women just become intoxicated when they see golden jewels. It's true for some men – the homo- and metrosexuals – too.

Related: Roy Dalio, the founder of the world's largest hedge fund, explains why the Bitcoin is a bubble, not a currency, in this video.

So the value of gold was clear from the beginning. Some people, especially women, were amazed by its shine (and by their apparent higher status relatively to other women) and even if you found this hype superficial, you could control these people by having gold. So even to a skeptic who is unexcited by gold, the gold had a clear value because it allowed them to influence the behavior of others who consider gold amazing and precious. Let me mention that the Czech atheists realize the "value of crosses in the churches" because of a very analogous indirect reason.

OK, Joe Rockhead, a butcher, didn't have meat that he used to barter but he needed to buy some old whiskey, anyway. He had a golden ring previously obtained from the Rubbles. So he offered the golden ring instead of the meat and it was acceptable for both sides. They simultaneously invented the payments in gold. Next time, it was easier to do the same thing. Last time you paid by gold instead of meat, why don't you try it again?

The "discovery" of the gold-based payment system wasn't any deep theoretical revolution in science – not even a result of a groundbreaking bitcoin.pdf paper. It was nothing else than a common sense practical solution picked by two rather ordinary people in distress that worked OK for both sides and had no reason not to be repeated by themselves and others.

This habit has evolved gradually and naturally. People were mining and purifying gold, creating jewelry and then standardized coins. Transactions became so frequent that the prices of products in gold got stabilized. Gold currencies were born. Silver coins were around as well. Monarchs typically had lots of precious metals (usually stolen from someone else during military excursions) and they could motivate everyone in their kingdom to work regularly, by promising them a portion of their gold and silver reserves every year. Lower-level aristocrats and others, later capitalists, emulated this behavior. The silver-to-gold price ratio should have been determined by the free market but no one had a clue what it should have been, anyway. Instead, in most cases, the price ratio was defined by a decree of a monarch.

I want to emphasize that no one has ever declared a new, previously worthless, object to be "valuable" and a "new currency". That just couldn't work. No one would ever agree to consider a previously worthless thing valuable! In fact, the price wasn't even artificially discontinuously enhanced, ever. Gold is useful for teeth, jewels, and technical applications, so it's valuable even without its currency status. Fourty years ago, gold was abandoned as a basis of the U.S. dollar but the gold price didn't collapse. It's still basically the same – although oscillating – as it was during the gold standard era.

Paper banknotes were covered by gold. "This banknote is a receipt that you can trade it for XY amount of gold in a central bank," the banknotes would implicitly if not explicitly say for a long time. Richard Nixon abandoned the gold standard in the U.S. but he didn't create any value out of thin air. The banknotes' values were previously linked to gold – and therefore to products etc. – but almost no one would ever demand his gold for the banknotes, so the peg was purely abstract, anyway. The real reason why the banknotes were considered valuable were fixed commitments and contracts – and price stickers – that basically guarantee that you can buy certain things for a predetermined number of dollars in the future.

The value of the banknotes was originally "derived" from gold – by commitments that were apparently enforced rather efficiently – so the banknotes were "derivatives" in some primitive sense. In the same way, bonds guarantee that you can get some cash, so they have some value derived from the cash, too. And then you can have more complex derivatives etc. The value of all these things is ultimately linked to something else that already had a value before the derivative was created. You can't peg a currency to thin air because thin air isn't solid (unless you freeze it).

Central banks target inflation (or nominal GNP growth, as in a clever Swedish modification of this system) so the value of the fiat currency is predictable in the future relatively to something we can imagine and something that is independent of the choice of units. These targeting mechanisms are more or less strictly, more or less precisely enforced by the law. So you can basically rely on these predictions of the currency's value in the future.

The removal of the gold standard hasn't created any discontinuity in the U.S. Outside the era of Stalinism, there were no real major discontinuities in Central Europe, either. The Czech currency is a spectacular example of that. You can trace it to some golden and silver coin in the Middle Ages. They were sometimes renamed but the essence stayed the same. In 1892, the Austrian-Hungarian emperor Francis Joseph I made a minor currency reform. One gulden was renamed to "2 crowns". (As of 2017, Czechs still use the slang "pětka", or a "five-girl", for the ten-crown coin: it's equivalent to a 5-gulden coin used up to 1892.) The unit was renamed and the new unit was equal to one-half of the previous one. Clearly, this changes nothing about the ratios of wealth and ratios of prices.

In 1918, Czechoslovakia was the only successor state of the monarchy that kept the currency's name. For the new Czechoslovak citizens, one Czechoslovak crown was converted from one Austrian-Hungarian crown, at parity. In the late 1930s, Nazis had the power to "enforce" non-market exchange rate, so they weakened the Czechoslovak crown by some 30% overnight. Instead of 6.7 per Mark, you got 10 crowns per Mark. German shoppers invaded Czech grocery stores simultaneously with the Nazi soldiers. OK, one protectorate crown was introduced, at parity. Post-war elimination of alternative currencies and the restoration of the protectorate crown, at parity. The Czechoslovak crown continued up to February 1993 when the currency union with Slovakia had to be divided due to the speculative transfer of cash to banks on the Czech territory (where the speculators were likely to get a "more expensive" successor crown after the possible split – which indeed did have to happen, as a self-fulfilling prophesy). The Czechoslovak crown banknotes were converted – by a simple stamp – to the Czech or Slovak crown, at parity. Czechia keeps the Czech crown as of 2017 and it will be so for at least for 5 more years. Slovakia has joined the Eurozone.

The Euros used in Slovakia weren't wealth created out of thin air, either. The old Slovak crowns were just converted to the Euros at the rate of 30.1260 slovak crown per Euro. Look at the amazing accuracy. No one has ever depended on this accuracy but the accuracy exists and several digits were really necessary for a smooth transition. The accuracy has nothing to do with the Bitcoin whose value changes by 20-30 percent a day in a random direction and no one seems to care. Countries that were joining the Eurozone obviously had to stabilize their exchange rate relatively to the Euro for some time before they joined. It's common sense.

All the abandoned European currencies have a fixed exchange rate relatively to the Euro. Most importantly, one Euro is equal to 1.95583 German marks. This was an exchange rate that had to be stabilized, and then kept, before the transition was possible. The financial institutions really had to do it very precisely – it's like the speed of two trains that must be equal if you want to jump from one train to the next one. You may say that the German Mark still exists, albeit it's used rarely. Its exchange rate has been fixed.

No wealth was ever created out of thin air. 1.95583 German marks were simply renamed to one Euro. It was an operation involving a new design of banknotes and coins – something that countries often do even if they keep the same currency – combined with a simple multiplicative rescaling of the units – which is no more mysterious than switching from inches to centimeters. Nothing changes about the essence.

In the same sense, nothing changes about the essence when the currencies are inflating. A 2% inflation is equivalent to changing your banknotes' real value by 2% each year. Imagine a country with no inflation. On January 1st, every year, old $100 banknotes are collected from the people and the people get new $102 for each old $100. Clearly, the effect will be exactly the same as inflation – in the inflating world, the people get their new $2 in terms of the higher-than-otherwise interest rates in the bank (the interest rates automatically go up when inflation does). The people who think that inflation makes some dangers grow or makes the people unavoidably poorer just haven't understood the concept of multiplication. Inflation is just a time-dependent change of units and units change nothing about the substance. In Maldacena's jargon, the time-dependent changes of units such as inflation are a noncompact version of the \(U(1)\) gauge symmetry, the local Weyl symmetry.

In particular, all the price ratios and wealth ratios stay the same. Imagine that you plan a switch to a new currency at moment \(t\). Alice and Bob are two folks that own certain things. Their wealth before the monetary reform, in the old units, are denoted \(W(A,t-\epsilon)\) and \(W(B,t-\epsilon)\) where \(W,A,B\) stands for wealth, Alice, Bob, respectively. What happens after the currency reform? The units change but\[

\] The ratios of the wealth of the two people before the monetary reform and after the monetary reform have to be equal, at least with a good enough accuracy. This ratio may be determined by trade or even bartering so it is independent of the choice of the units. If Alice is 5 times wealthier than Bob before the monetary reform, she has to be 5 times wealthier than Bob after the reform, too. If she were 6 times wealthier, it's clear that the reform was a "method for the likes of Alice to rob the likes of Bob", while if it were just 4 times, the reform would be a "method of the likes of Bob to rob the likes of Alice". In these two cases, Bob and Alice would probably oppose the monetary reform as unjust!

I want to emphasize that this "constancy of the wealth ratios" (and similarly price ratios) was true in every single "reform" that was adopted in the past – with the exception of several Stalinist currency reforms that included robbery (left-wingers have also killed some 100 million people in the last 100 years so robbery is among the more decent things that they are famous for). It's common sense that big fractions of the society would revolt against a monetary reform that would include a decrease of their wealth relatively to the wealth of others!

In the past, no one would respect a nonzero, let alone big, value of something that was previously worthless just because of the explanation that "it could be a new currency". Neither gold nor the Euro or other things have ever gotten this nonzero or large value discontinuously, as I discussed.

In the case of the hypothetical switch of the world to the Bitcoin as a currency, you need the current capitalization of the Bitcoin between 50 and 100 billion dollars – I don't want to be more precise than that because every other day, the price changes in this interval wildly – to be multiplied at least by a factor of 100, probably rather 1,000.

The last people who would join the "new currency" would therefore be getting 100-1,000 times less for their dollar or crown than the people who are switching now – and millions or billions times less than the people who switched in 2013 or 2010. The two Alice-Bob ratios wouldn't be equal; they would differ by a factor between 100 and billions! Why would the last people be switching if they know that they're being robbed. There clearly comes a moment in which it will be obvious to everybody who hasn't switched yet that they're already too late. So the decision to support this redistribution scheme would be almost suicidal for them. They just won't be buying the overpriced Bitcoin for their dollars that needed hard work to be earned. They will keep on using the dollars instead because they rightfully see that the invitation to switch to the Bitcoin is a method to complete and certify the robbing of their wallet. They will wait for the collapse of the Bitcoin so that they will switch e.g. from the poorer 1/2 of their nation back to the wealthier 1/2 again!

We may already be approaching the moment in which it's obvious that if you haven't bought the Bitcoins yet, you are already late to the hypothetical party, and you are therefore among the "donors" in the planned giant wealth redistribution scheme.

At any rate, everyone who finds it inconvenient to join the party now has a good ally – the non-existence of any "floor" or fundamental calculation of the Bitcoin price. The price has collapsed 40% in a week in the first part of September 2017. But the price may crash by 99% a day, too. There is absolutely no mechanism that makes such things impossible so they may happen and some of them will happen.

Big fish were only buying the Bitcoin as an extreme speculative vehicle. They have never bought a coffee, let alone anything larger, for the Bitcoin. This is true for the wealthy guy whom I sold BTC 0.199 last week. They entered the Bitcoin when it was $300 or so and they let the bubble work and be inflated. Meanwhile, those who are doing the hard work of inflating it now are doing so because they are being told – and they are often trained to parrot – that the Bitcoin is going to become a major currency for payments. But an overwhelming majority of the Bitcoins are simply not used for payments – they're extreme speculative bets by assorted billionaires and minor billionaires – and there exist no signs that it's gonna change.

No one is really using the Bitcoin for payments because "safe enough business" must include the conversion of the Bitcoin from and back to a more stable currency. If you were selling the iPhones X ($1,000) in Bitcoins, they would cost something like BTC 0.25 today. But if you fixed the price at BTC 0.25 for the next month, you would almost certainly

either see the value of BTC go up, so people wouldn't be buying your phones because your price would be above $1,000 and they could buy it for $1,000 elsewhere

the Bitcoin's value would go below $1,000, your price would be cheap, but your profits would drop or become losses.

So you just can't do it. You must think about prices denominated in a stable enough currency such as the U.S. dollar. And you need to calculate the price in the Bitcoins at every moment. And you should better convert your dollars to the Bitcoins before you buy something, and back after you sold a product. Everything else is too risky. So the Bitcoin payment must really be combined with two conversions between the Bitcoin and a stable currency. At that moment, it becomes inconvenient.

And it will always be inconvenient. The price of the Bitcoin may only naturally stabilize if people offer "fixed prices expressed in BTC" but they will only do so if the Bitcoin price is already stable enough. It's a vicious circle! This vicious circle is unavoidable because the price of the Bitcoin now, whether it's $3,000 or $5,000, is just the result of the Bitcoin users' calculation of the number zero, including the error margin. The whole value $3,000-$5,000 is within the error margin because it is exactly equal to the error of their calculation. Within the error, the value of the Bitcoin is exactly zero, of course. Volatility of order 100% is unavoidable if error margins or errors are everything you own!

The only way how a cryptocurrency could stabilize would be if a big player, like a central bank, stabilizes it actively. It just pegs it to a stable currency or many currencies or other stable things in one way or another, and promises interventions to keep this peg. Needless to say, the "independence" of the cryptocurrency will be gone. It really has to be abandoned if the cryptocurrency is supposed to become a currency – which it simply cannot be if the huge volatility persists.

It's very ironic that the Bitcoin cultists criticize the fiat money because they're "money that the central banks can create out of thin air". But in reality, this is never the case and it has never been the case in the course of history. The fiat money were always exchanged at a fair market value – and a stable enough value – for something that previously was acknowledged to have a rather constant value, too. The only would-be currencies whose value is supposed to be created out of thin air are the cryptocurrencies. So the Bitcoin cult criticizes the standard fiat currencies for something that the fiat currencies don't suffer from – and instead, the Bitcoin and altcoins are the only systems that suffer from that lethal flaw or "lack of basic morality", depending on how you want to view it!